How Companies Should Prepare Thier Forecasts

Digital
Article
Forecasting
How Companies
Should Prepare Their
Forecasts
by C. Fritz Foley and Mark Khavkin
This document is authorized for educator review use only by LAHORE UNIVERSITY OF MANAGEMENT SCIENCES, Lahore University of Management Sciences until Jan 2024. Copying or
posting is an infringement of copyright. Permissions@hbsp.harvard.edu or 617.783.7860
HBR / Digital Article / How Companies Should Prepare Their Forecasts
How Companies Should

Prepare Their Forecasts
by C. Fritz Foley and Mark Khavkin
Published on HBR.org / April 15, 2019 / Reprint H04WGS
Erik Dreyer/Getty Images
Senior management teams tend to focus on achieving results that will

show up on their most current income statements. For weeks on
end, significant internal resources are allocated and frequent board
meetings are held to formulate explanations for recent earnings or revenue
growth.
This focus is understandable. Analysts who cover public companies tie

earnings to stock prices. Silicon Valley investors view the last quarter’s
growth rate as a key determinant of a growth company’s valuation. But we
have found that particularly strong management teams actually spend less
Copyright © 2019 Harvard Business School Publishing Corporation. All rights reserved. 1
time obsessing over the current income statement and more time focusing
on a different report: the forecast.
There are several reasons for this. To start, the forecast is a vital tool for
value creation. Finance theory points out that the value of an enterprise is
the present discounted value of its future cash flows, and the forecast
provides a road map for earning those cash flows. The forecast also
provides a scorecard to evaluate if strategy is appropriate and effective,
and directs attention away from short-term results towards longer-term
strategic objectives. Furthermore, the forecast guides actions by providing
inputs needed to execute operational initiatives. For example, Pantheon, a
Platform-as-a -Service, venture-backed company in San Francisco, where
one of us is CFO, traces the difference between realized growth and
forecasted range to assumptions about core business drivers and unlocks
specific product initiatives. This allows the company to adjust its resource
allocation between long-term product investment and shorter-term
marketing investment depending on the findings.
Not all forecasts are built alike, however. We find that a great forecast has
five attributes. First, it includes projections of operating results and
resource needs for the next 3-5 years. Typically, firms only give investors
guidance about anticipated financial results over the subsequent year. A
longer horizon can begin to shed light on the impact of new initiatives that
do not illustrate immediate returns.
Second, a great forecast reflects the firm’s industry context. It should be

consistent with estimates of the size of the firm’s total addressable market
and insights about how that market is evolving. Third, the firm’s strategic
choices should form the basis for assumptions about how it will grow and
what resources it will require.
Fourth, projected growth rates and margins should reflect the competitive
dynamics the firm faces. Anyone who projects high growth rates must
explain how much market share the firm will capture. In addition, anyone
who projects high margins over the duration of a forecast must support
this assumption with arguments indicating that the firm has a competitive
advantage that is sustainable. Finally, a great projection and the
subsequent after-the-fact analysis involves action items for non-financial
executives and their teams. Employees throughout the organization should
have a sense of the steps they will need to take to meet the strategy’s
financial targets given the industry context and competitive dynamics. The
organization should treat each review of forecast performance as a
learning opportunity to deepen the understanding of its operating
environment and inform future operational choices.
Instead of emphasizing the development of a single base-case forecast, it is

often more informative to consider a range of possible outcomes. Byron
Pollitt, who served as the CFO of Walt Disney Parks and Resorts, Gap Inc.,
and Visa Inc., and is a frequent speaker in a Harvard Business School class
on CFOs, advocates for a process that develops three sets of assumptions.
These are a set of conservative assumptions, which are met or exceeded
with a 75% probability; a base case, which is met with a 50% probability,
and a set of aggressive assumptions, which are met with a 25% probability.
This process captures a more complete picture of the opportunities and
risks a firm faces and generates a lively discussion of what considerations
should and should not be included in the base case.
The forecast is a living instrument and should be periodically updated to

reflect any changes in circumstances. Amendments to the forecast are
particularly important for firms in evolving business environments or
firms that are transforming. For example, Microsoft embraced the use a set
of rolling forecasts as it pursued opportunities to grow its commercial
cloud business. Such forecasts embody the view that things do not
typically go according to plan and there is value in taking a first step,
adjusting, and then continuing to head in the most promising directions.
Importantly, great forecasts do not have to prove to be correct to be worth

the trouble of constructing them. A higher degree of accuracy enhances
the reliability of any guidance a firm might give, helping avoid credibility
issues that can arise when investors are surprised. But even if the base case
does not materialize, the forecasting process deepens manager’s
understanding. By forcing management teams to detail the risks they face
and to consider the resources needed to pursue opportunities that might
emerge, the forecasting process helps those teams develop a playbook for
situations that may arise.
To start evaluating your forecasting process, try this simple exercise. Pull
together forecasts generated over the last five years. For each key item,
generate a graph that shows how forecasts have evolved and realized
results. As an example, consider revenues. Plot the path or projected
revenues over time in each forecast, generating a set of lines, one for each
forecast. Then also plot realized revenues. Examining this graph reveals if
the forecast process yields results that are systematically different from
subsequent results and raises questions about how and why any
differences might exist. One example of that comes from Harvard Business
School, where one of us is a professor. The school’s revenue estimates tend
to be conservative, but for a reason. This approach is sensible because it
diminishes the possibility that the school runs an operating deficit and
must pull resources from reserves of the endowment to cover its costs.
Some senior managers complain that financial reporting requirements

push them to focus on short term results. But in many cases this is really a
failure of leadership, not finance. Leaders who focus on forecasts and
integrate the finance function into their decision making stand the greatest
chance of creating value for investors.
C. Fritz Foley is the André R. Jakurski Professor of Business

CF Administration, Finance Unit, and Senior Associate Dean for Strategic
Financial Planning, at Harvard Business School.
Mark Khavkin is the CFO of Pantheon Platform.

MK

How Companies Should Prepare Thier Forecasts

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

How Companies Should Prepare Thier Forecasts

Uploaded by

Copyright:

Available Formats

Digital

How Companies Should

Erik Dreyer/Getty Images

Senior management teams tend to focus on achieving results that will

This focus is understandable. Analysts who cover public companies tie

Second, a great forecast reflects the firm’s industry context. It should be

Instead of emphasizing the development of a single base-case forecast, it is

The forecast is a living instrument and should be periodically updated to

Importantly, great forecasts do not have to prove to be correct to be worth

Some senior managers complain that financial reporting requirements

C. Fritz Foley is the André R. Jakurski Professor of Business

Mark Khavkin is the CFO of Pantheon Platform.

You might also like